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Optimal Income Taxation: Mirrlees Meets Ramsey

Author

Listed:
  • Heathcote, Jonathan

    (Federal Reserve Bank of Minneapolis)

  • Tsujiyama, Hitoshi

    (Goethe University Frankfurt)

Abstract

What structure of income taxation maximizes the social benefits of redistribution while minimizing the social harm associated with distorting the allocation of labor input? Many authors have advocated scrapping the current tax system, which redistributes primarily via marginal tax rates that rise with income, and replacing it with a flat tax system, in which marginal tax rates are constant and redistribution is achieved via non-means-tested transfers. In this paper we compare alternative tax systems in an environment with distinct roles for public and private insurance. We evaluate alternative policies using a social welfare function designed to capture the taste for redistribution reflected in the current tax system. In our preferred specification, moving to the optimal flat tax policy reduces welfare, whereas moving to the optimal fully nonlinear Mirrlees policy generates only tiny welfare gains. These findings suggest that proposals for dramatic tax reform should be viewed with caution.

Suggested Citation

  • Heathcote, Jonathan & Tsujiyama, Hitoshi, 2015. "Optimal Income Taxation: Mirrlees Meets Ramsey," Staff Report 507, Federal Reserve Bank of Minneapolis.
  • Handle: RePEc:fip:fedmsr:507
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    References listed on IDEAS

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    1. Emmanuel Saez & Stefanie Stantcheva, 2016. "Generalized Social Marginal Welfare Weights for Optimal Tax Theory," American Economic Review, American Economic Association, vol. 106(1), pages 24-45, January.
    2. Matthew Weinzierl, 2011. "The Surprising Power of Age-Dependent Taxes," Review of Economic Studies, Oxford University Press, vol. 78(4), pages 1490-1518.
    3. Thomas Piketty & Emmanuel Saez, 2003. "Income Inequality in the United States, 1913–1998," The Quarterly Journal of Economics, Oxford University Press, vol. 118(1), pages 1-41.
    4. Michael P. Keane, 2011. "Labor Supply and Taxes: A Survey," Journal of Economic Literature, American Economic Association, vol. 49(4), pages 961-1075, December.
    5. Roland Benabou, 2000. "Unequal Societies: Income Distribution and the Social Contract," American Economic Review, American Economic Association, vol. 90(1), pages 96-129, March.
    6. Conesa, Juan Carlos & Krueger, Dirk, 2006. "On the optimal progressivity of the income tax code," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1425-1450, October.
    7. Jonathan Heathcote & Fabrizio Perri & Giovanni L. Violante, 2010. "Unequal We Stand: An Empirical Analysis of Economic Inequality in the United States: 1967-2006," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 13(1), pages 15-51, January.
    8. Gouveia, Miguel & Strauss, Robert P., 1994. "Effective Federal Individual Tax Functions: An Exploratory Empirical Analysis," National Tax Journal, National Tax Association;National Tax Journal, vol. 47(2), pages 317-339, June.
    9. J. A. Mirrlees, 1971. "An Exploration in the Theory of Optimum Income Taxation," Review of Economic Studies, Oxford University Press, vol. 38(2), pages 175-208.
    10. Emmanuel Saez, 2001. "Using Elasticities to Derive Optimal Income Tax Rates," Review of Economic Studies, Oxford University Press, vol. 68(1), pages 205-229.
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    Cited by:

    1. Matus Senaj & Zuzana Siebertova & Norbert Svarda & Jana Valachyova, 2018. "The Evaluation of Fiscal Consolidation Strategies," International Journal of Microsimulation, International Microsimulation Association, vol. 11(3), pages 39-58.
    2. Michal Horvath & Matus Senaj & Zuzana Siebertova & Norbert Svarda & Jana Valachyova, 2018. "Evaluating the Aggregate Effects of Tax and Benefit Reforms," Working Papers Working Paper No. 1/2018, Council for Budget Responsibility.
    3. repec:eee:inecon:v:108:y:2017:i:c:p:387-412 is not listed on IDEAS
    4. repec:eee:ecmode:v:75:y:2018:i:c:p:38-69 is not listed on IDEAS
    5. Islam, Nizamul & Colombino, Ugo, 2018. "The case for NIT+FT in Europe. An empirical optimal taxation exercise," Economic Modelling, Elsevier, vol. 75(C), pages 38-69.
    6. Antràs, Pol & de Gortari, Alonso & Itskhoki, Oleg, 2017. "Globalization, inequality and welfare," Journal of International Economics, Elsevier, vol. 108(C), pages 387-412.
    7. Norbert Švarda & Matúš Senaj & Michal Horváth & Zuzana Siebertová, 2015. "The End of the Flat Tax Experiment in Slovakia," Discussion Papers 33, Central European Labour Studies Institute (CELSI).
    8. Norbert Švarda & Jana Valachyová & Matúš Senaj & Michal Horváth & Zuzana Siebertová, 2018. "The end of the flat tax experiment in Slovakia: An evaluation using behavioural microsimulation linked with a dynamic macroeconomic framework," Discussion Papers 50, Central European Labour Studies Institute (CELSI).
    9. Olga A. Timoshenko & Erick Sager, 2016. "The EMG Distribution and Aggregate Trade Elasticities," Working Papers 2016-15, The George Washington University, Institute for International Economic Policy.

    More about this item

    Keywords

    Optimal income taxation; Mirrlees taxation; Ramsey taxation; Tax progressivity; Flat tax; Private insurance; Social welfare functions;

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household

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